Ask an Economist

E.g., Thursday, August 6, 2020
E.g., Thursday, August 6, 2020
Question:
Can a market failure occur when there is a high amount of risk within the market leading producers and consumers to avoid the market?
Answer:

To answer this question, it is critical to agree on the definition of "market failure." In what follows, by "market failure" we will mean a situation where a free market fails to provide an efficient allocation of goods and services (i.e., risk...

Question:
At the risk of sounding like a socialist, I wanted to ask about potential economic potential of a maximum wage. Sweden tried it with a 12:1 ratio, failed sadly, but I wondered if a less extreme idea would be viable. Say 100 times the minimum wage is the most anyone could earn in gross taxable wages. I'd probably say it would be fair to exclude athletes and entertainment industries. It would be a hard sell for congress so this is purely a theoretical question. Short of how the CEOs would feel, what is the viability and potential impact on the economy?
Answer:

I am not sure there is any deep reason why a government would want to set a cap on wages. What purpose would it serve, other than to curb income inequality by lopping off the top rungs of the ladder? If that is desirable, then there may be other...

Question:
I have been thinking about open market operations that the federal reserve performs to control the money supply and I have a question that I do not fully understand and it is bothering me. An answer to this question will be really appreciated.

Question: Let’s say that if the central bank is keeping the base money at 6% of the GDP then as the GDP expands then the central bank will also have to increase the money supply to keep it at 6% of the GDP. In that case the central bank will perform open market operations to pump extra money in the economy by buying treasury bills. Some of those treasury bills that central bank has on its balance sheet will mature and the central bank will have to replenish those by buying new treasury bills to keep the money supply constant at 6% GDP. So as the economy grows larger and larger, the central bank will be holding more and more treasury bills on its balance sheet and will have to conduct more and more open market operations to replenish the maturing treasury bills? Does that also imply that in an ideal world with no recession and constant GDP growth the central bank will always increase its balance sheet and the balance sheet of the central bank will not go down? Also, if the federal debt is paid off somehow then the central bank cannot use the treasury bill for open market operations so will they use some other type of instruments such as etfs to conduct open market operations? Thank you very much.
Answer:

The money supply and the size of the central bank’s balance sheet are closely connected. Currently and historically, the sum of currency and bank reserves (a narrow definition of the money supply) account for almost all of the Fed’s liabilities....

Question:
The way the economy is today, would it be bad if rich countries (US, EU and Japan) print money and instead of doing the QE (top bottom) inserted the money on a bottom up approach? And I know about the risk of inflation, but isn't it what we want right now? A little bit?

1) I'm talking here about rich countries with deflation or very little inflation, so a bit more of extra money in the market wouldn't be bad (it would be up to them to calculate this amount)

2) The money could be give to the poorest in the society. This money would go straight back to the economy since lower classes save very little (usually they spend the extra money or pay debts). So instead of the trickle down economics (which usually doesn't work) we would have a trickle up economics. Australia did it just after the 2008 GFC and it was one of the only developed countries that didn't go into recession. (although it took the money from its budget).

3) The QE amounted in trillions of dollars and not much of this money went to the real economy in terms of investment and the creation of jobs. A lot of it created an inflation of assets such as the growth of the stock market in US, a housing price hike in world cities such as NY, London, Sydney, LA and so on and even Art prices exploded...but not much to the real economy.

4) Corporations don't need more money in the form of tax breaks and cheap loans (they are swimming in cash). They need consumers to consume! So they know they have a market and be confident to invest in new projects. And with the squeeze of the middle class in rich countries, we are not consuming as much as we need to keep the economy growing.

5) I don't know how much money would be enough to kick start (or improve) the economy of Japan, Europe and US without a dangerous inflation but it could be done in 4 installments along the year to the poorest families. Image something like 4 x 200 USD in one year. This money would make a big difference for low-income families and would flood directly to the economy...and companies would know that the money would come and they could prepare themselves.

6) The dollar is pretty strong now and it's becoming a problem for the US and the rest of the world. So printing a bit might not hurt much.

7) A few years ago negative interest rates were seen as something out of this world. But now Japan, Switzerland and Sweden have it. We just need to think out of the box to improve this economy in a more inclusive way....no middle class, no economy and no democracy!

8) Obviously, this wouldn't work with developing countries with weak currencies and inflation...but for US, EU and Japan...why not?
Answer:

There are several issues here. First, the US central bank, the Fed, is an independent monetary authority and does what it thinks best to keep inflation and unemployment low. They cannot be "asked" to print more money or change interest rates....

Question:
Dose any branch of the field of economics have a term for when producers cease to compete at the production level, but continue to compete fiercely in marketing. The example I have in mind for this is the sports shoe industry (Rebok, Nike, Adidas, etc.), where production has been subcontracted to East Asian companies that specialize in finding the lowest cost producers in China, Vietnam, Indonesia, etc., where the same manufacturer can be in the business of making shoes in the same factory for several companies (Rebok, Nike) at the same. And what precisely are the theoretic conditions that enable this to happen? Are production costs that their absolute lowest so that no production competition is possible?
Answer:

The term you are looking for is product differentiation. This is the name we give to a class of models (most prominently, the Hotelling linear city and Salop circular city models) where firms may have identical production costs and competition is...

Question:
I know that when there is too much of something the value of that item goes down. If the money supply of US Dollars goes up drastically that will that lead to or cause inflation of the US dollar or a decrease in its value. According to an article I am referencing *," When inflation starts to bubble up, Treasury inflation-protected securities can turn down the heat on your portfolio. Issued with the full faith and credit of the U.S. government, TIPS are one of the few investments guaranteed to earn, under normal circumstances, a "real," or after-inflation, return. Their principal value adjusts in sync with the consumer price index and, because the coupon payments on TIPS cue off this adjusted principal figure, the bonds pay an inflation-indexed income, too."
So my question is: if the US dollar loses 10 % of its value to inflation, how much will the bonds return? In dollar amounts- a $5000 investment in Treasury inflation-protected securities should yield how much?
* http://m.kiplinger.com/article/investing/T041-C000-S002-why-you-need-tips.html
Answer:

Suppose that $5000 is the face value or redemption value (not the market price at which an investor may have bought it) of a 5-year TIPs. Suppose that it promises to pay an annual coupon payment of 1% or the amount of $50 at the time of purchase...

Question:
I watched President Obama’s speech this last week, and I didn’t understand something. He said he’s cut the deficit by 2/3. Yet, we need the debt ceiling raised in order to avoid a government shutdown. Why? If I were to pay down 2/3’s of my debt, I would have a larger amount of credit available to me. What am I missing?
Answer:

You are missing a key difference between the federal budget deficit and the public debt level. The deficit shows by how much the federal government expenditures exceeded its revenues in a given fiscal year; the deficit is measured per year. In...

Question:
Can you tell me, please, what the projections are for the U.S. and State of Iowa work forces? What is the likely composition of those work forces, and where/how would we be smart to recruit in order to build the strongest pool of workers over the coming years?
Answer:

The U.S. Bureau of Labor Statistics has an annual projection of employment and labor force growthThe most recent is Employment Projections: 2018-2028, available...

Question:
One of the macro economic indicator that is monitored by organizations is "the contribution of construction to the GDP". This is measured in terms of percentage contribution of construction.

My question is:
What does this comprise? Does it include large infrastructure projects/oil refineries/nuclear plats etc or not?
Answer:

As you probably have seen already, you can find the measure of value added to GDP per sector of the US economy at the Bureau of Economic Analysis website, specifically at this web address: https...

Question:
With all the killing of poultry by bird flu and euthanizing that will this do to the retail poultry prices?
Answer:

Avian influenza has continued to spread, particularly in flocks of egg-laying hens. When a farm encounters a case of avian influenza, some birds die and others are euthanized. In the immediate short-run, this translates into a direct reduction in...

Question:
Can an economist call the economy good when there is low unemployment, good profits, but great income disparity? Is it within the realm of the social science of economics to consider social justice?
Answer:

Economists measure the economic health of a country by its G.D.P per capita. They see low unemployment as good because it means labor resources are not sitting idle. They also consider whether income disparities are good or bad. In fact, these...

Question:
Hi!

I wanted to value a high-tech start-up of which I have the cash flows of the coming 6 years. I am not a VC just a post-grad student, so I decided to use the discounted cash flow method. To do so, I calculated the discount rate. For a high-tech start- up the discount rate = Rate of equity (which can be determined by the capital asset pricing model). So I calculated my discount rate, used it in the DCF model, and found an approximation of the value of the high-tech firm.

But I didn't take into consideration that the company sells their products globally. This fact has an impact on its beta factor, and consequently on the discount rate, and finally on the value of the firm!

One option is to use the International CAPM model, but my company is going to sell globally, so how do I know the impact of that to the discount rate? Any help would be very appreciated.

Thanks
Answer:

If your company is based in the U.S., the valuation should be based on the standard CAPM. However, barring exceptional circumstances, one would expect the beta of such a firm to be closer to zero than the beta of an otherwise identical firm...

Question:
Using the worst case scenario (Illinois), what are the economic implications of underfunded pension plans?
Answer:

The problem of underfunded pension plans is complex. Some possible economic effects are as follows.

1. Plan beneficiaries will suffer economically in retirement unless they are bailed out by taxpayers. Whether and how much to bail them out...

Question:
In Canada, where I live, there has been much talk lately about the need to build more pipelines to export oil from Alberta. Western Canadian Select (WCS), the benchmark for bitumen from the oil sands, trades at a discounted price compared to higher quality products like West Texas Intermediate (WTI), for example. While the difference in quality accounts for most of the price differential between the two, the rest of the price discount can be explained by export bottlenecks, apparently. Since oil production in Canada exceeds the capacity of existing pipelines to export the oil to refineries in the US, oil producers turn instead to rail companies to export the oil.

1) Why does a transportation bottleneck cause Canadian oil to trade at a discounted price? Is it simply because rail companies have more leverage in this situation, as they have an effective monopsony as a buyer, a.k.a. near-monopoly over transportation? And if that's the case, is the oil sold to the rail company, who is able to negotiate a discounted price at which to purchase the oil from the producer?

I suspect it may have something to do with the fact that rail companies seek to secure long-term contracts with clients, so when oil producers want to use rail services just for the short-term, until new pipelines can be built, rail companies refuse to pay a high price for the commodity being transported (alternatively, rail companies demand a higher fee to transport the commodity). But again, I'm not clear about whether or not rail companies actually purchase the oil and then sell it on to refineries. And if a Canadian rail company does purchase the oil, then the revenue stays in Canada, doesn't it?

2) I have read that rail transport only adds marginal export capacity compared to what's needed, so perhaps the oil producer/rail transaction has a negligible effect on price? If that's true, then I'm really confused.

3) Is it simply just that a transportation bottleneck causes excess oil supply to build up, reducing its market price? But I thought that a bottleneck would equate to less supply, since it can't be exported as quickly, and therefore its market price should rise.
Answer:

Great question!  In general, we don’t need a monopsonistic setting to explain crude differentials between WCS and WTI.  In a competitive market, prices for the same product (oil, corn, etc.) can diverge in different markets for two...

Question:
What would happen if the minimum wage laws were repealed? Would businesses pay their employees a penny an hour?

If raising the minimum wage to $10.10 would be good for the economy, wouldn't raising it to $20 be better? If not, at what point are the good economic effects of a minimum wage outweighed by the bad?
Answer:

If minimum wage laws were repealed, the vast majority of U.S. workers would not have their wages impacted. Through supply and demand, competitive market forces drive up the wage rates of most workers to levels considerably above the current...

Question:
Was it Truman's intention to begin paying down the debt after WW2? If so, what happened to prevent it? And was there any way that the public would have known that the debt was not to be whittled down to the same extent that had always been attempted previously? Was it the result of an announced policy, or simply something that was never gotten around to?
Answer:

To begin with, the premise of this question is somewhat mistaken.  As was true in earlier wars, WW II did cause a large expansion of federal government debt both absolutely and relative to GDP.  Indeed, the debt/GDP ratio reached about...

Question:
What are the major pieces of literature on Agricultural economics as well as the household names when it comes to Agricultural economic research?

I am mathematics major student with an MA in Economics, I am developing an insatiable interest in Agricultural economics and would like to read more on research in this area. I would like to be guided on the body of literature making names in this field.

I will particularly be interested in works that apply econometric techniques using time series econometrics and forecasting, panel data.
Answer:

Handbook of Agricultural Economics

Editors: Bruce L. Gardner and Gordon C. Rausser

Volume 1, Part A, Pages 3-741 (2001)

Agricultural Production

Volume 1, Part B, Pages 745-1209 (2001)

Marketing, Distribution and...

Question:
Why has Saudi Arabia released so much oil for sale that prices for that have dropped so fast? Does that country have a lot of debt? Does it relate indirectly to the economic slow down in China?
Answer:

Currently, Saudi Arabia’s foreign exchange reserve is about $600 billion. Saudi’s oil export is about 8 million barrels per day, or about 2800 million barrels per year. At $100 per barrel, their revenue from oil exports would be about $280...

Question:
Hi! I'm trying to do more reading on economics this summer as I consider applying to master's of economics programs after working in IT for 13 years. I came across a paper (linked at the bottom) on inequality. I only have an undergraduate level understanding of economics and statistics (think intermediate micro/macro and an introductory stats class I took around 2003) so I'm limited in my understanding.

I'm reading through this paper and while I can think of reasons why some of the conclusions might be true I don't get how empirically they are reaching their conclusions.

1) According to page 16 item #23 "The empirical results show that inequality has a negative impact on economic growth. The baseline results are reported in columns 1 to 4 of Table 1" and then goes on to explain its reasoning why inequality negative impacts growth and says "Based on the estimated coefficients in column 1, for example, lowering inequality by 1 Gini point would translate in an increase in cumulative growth of 0.8 percentage points in the following 5 years".
2) In item #29 (page 19) they go on to say "Taken together, these results suggest that inequality in disposable incomes is bad for growth, and that redistribution is, at worst, neutral to growth". Again while I can think of some reasons why this may be the case (and some reasons why it may not like if some of the wealth leaves the country so as not to get redistributed depending upon implementation) I'm not sure how they are coming to that conclusion empirically.
3) Then several times they estimate what the impact on growth would be for every % change in the Gini index but I'm not sure how they built that numerical assumption.

I came across the paper because I was trying to do some simple research into whether income inequality can lower the velocity of money (though so far I've just pulled some data from FRED on MZM and the Gini index and found like a -.46 correlation.

I'm hoping I could learn from someone to better understand how the tables this paper provides actually translates into the conclusions they claim; I don't know how to properly interpret the tables.

https://www.oecd-ilibrary.org/social-issues-migration-health/trends-in-income-inequality-and-its-impact-on-economic-growth_5jxrjncwxv6j-en;jsessionid=g-XlVT6DTb4_r_CW_3M5veza.ip-10-240-5-57

Thanks!

Christopher

Answer:

1) According to page 16 item #23 "The empirical results show that inequality has a negative impact on economic growth. The baseline results are reported in columns 1 to 4 of Table 1" and then goes on to explain its reasoning why inequality...

Question:
Do GDP figures include depreciation of infrastructure? What about other forms of depreciation, eg. consumption of non-renewable resources, or consumption of renewable resources at a greater than the sustainable rate?
Answer:

There is a large literature that attempts to adjust the various conventional measures of economic growth for the effects of environmental degradation. There is a useful Wikipedia page on the topic (...

Question:
Hi there, thanks for taking the time to answer my question.

I understand the basics of measuring GDP based on the product, income, and expenditure approaches, but I am stuck on a simple question: how are household savings accounted for using the expenditure approach if they are not invested?

In other words, say I earn $100, spend $98, and deposit $2 in a non-interest earning savings account. If the $2 (along with a lot more money, presumably) gets lent out to a company that builds a factory, then clearly that would be investment, but what if it just sits in the savings account? Does that count as “residential investment”?
Answer:

There are two components to investment in the national income identity. In addition to expenditure on capital equipment and buildings by firms, investment also includes additions to business inventories (goods that firms did not sell). So if you...

Question:
When Minimum Wage is increased by more than 5%, studies have shown a negative impact for one to three years - job loss, reduction of hours, and non-hiring to replace workers leaving - causing a reduction of pay of low pay workers, a 1-3% reduction in teenager hired, and failure of many start-up businesses. I have not found longitudinal studies showing where the economy rebounds from these losses and whether there is a long-term benefit at all for the lower or higher wage workers. Has there been studies going longer showing when the (a) teenage hiring returns to previous levels, (b) hours return to normal for the low pay workers, etc... Is Minimum Wage a permanent negative impact or temporary? ... I've seen what happens statistically for things like holidays - where a sick person will power through the holidays, but then die immediately thereafter, creating an average between "less deaths during the holiday" and "more death just following" matching normal death rates. And studies which show that capital punishment creates a permanent troth with an immediate reduction of several months after a criminal has been executed without a rebound increase afterwards ... just a return to normal levels. .... So which is it, a permanent loss to the economy when we have minimum wage raised that never recovers; a temporary loss to the economy which returns to the previous level but no further; a temporary loss to the economy but a rebound that balances and then return to average; OR a temporary loss to the economy but a long-term gain once everything is considered? Everything I have found indicates a permanent loss to the economy with no upside and that just doesn't make sense to me as yet. If there are longer studies, I would appreciate finding out about them. Asking because I would like to support a higher minimum wage, especially for tip-income wages, but based on the evidence I have found I cannot.
Answer:

The adverse effects of the minimum wage depend on how high it is compared to the prevailing wage in the area.  Because wages are higher in San Francisco than Des Moines, a $15 minimum wage in San Francisco, where the median wage is $25.11,...

Question:
If 25% of the US population left their 401k (and other retirement funds) alone, reduced contributions by 25%(50%, 75%, 100%), withdrew all non-penalized funds and kept personal savings out of their banks, did not otherwise invest their money, what would happen nationally, internationally, immediately, long-term?
Answer:

My best guess is that you are interested in the effects of investors withdrawing from the financial market (as opposed to the labor market or some other market).

If 25% of the US population suddenly changed their investment behavior as you...

Question:
Why is it that the largest market fluctuations, by a large majority, mainly happen in September, October and November? What about those three months causes the massive fluctuations? It happened in 1929, 1987 and 2008.
Answer:

At present, I am not aware of a widely accepted academic research in economics and finance that would provide a definitive explanation for the exact calendar timing of major financial market fluctuations in the United States for the time period...

Question:
I here a bit more these days about our being a consumer economy. What other types of economies are there?

Thanks a bunch!
Answer:

Ours is called a consumer economy because consumption is nearly 70% of our GDP. Countries like China, are more investment-driven with investment (often by the public sector) at nearly 50% of GDP. 

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